Europe Is Bracing for a Harsh 2023. 3 Sectors for Savvy Investors.
There are plenty of economists and executives warning about the risk of a U.S. recession next year. But the picture in Europe is decidedly worse.
In fact, the outlook for 2023 across the pond can be summed up in one word: grim. Germany and the United Kingdom, two of the region’s biggest economies, are probably already in recession. The 19-member euro area will likely experience a prolonged downturn as well, according to the latest forecasts from the European Central Bank and the International Monetary Fund.
The reasons boil down to Russia’s invasion of Ukraine. That sent energy prices soaring, especially natural gas, and curtailed Europe’s access to fuel supplies. Household bills are still surging, fanning inflation, prompting the European Central Bank to start its first interest-rate-hike campaign in a decade.
“Energy bills are going to stay high for some time,” says George Moran, an economist at Nomura in London. “Not only is that going to be depressing consumption because consumers have less disposable income, but on the business side of things, input costs have shot up massively.”
It’s a different situation than what has happened in the U.S. Although energy prices went up everywhere at the start of the year, they have since mostly come down in the States, and natural-gas shortages were never a problem. Inflation is still elevated in the U.S., but it’s driven by other things besides energy.
“The U.S. has been hit a lot less hard by high inflation,” Moran adds. Output in the U.K. and euro area is still at or below prepandemic levels, whereas the U.S. economy is a good 4% above where it was in the fourth quarter of 2019.
That means that investing in European companies will be tricky. Morgan Stanley predicts the biggest drop in corporate profitability in the region since the financial crisis a decade ago.
For analysts at J.P. Morgan, the best investment bet is to try to avoid companies that are more exposed to consumer spending. Along with higher prices, households will also be coping with rising European Central Bank interest rates. That means favoring healthcare, utilities, and possibly banks.
In Germany, that could be Deutsche Telekom (ticker: DTE.Germany) or Bayer (BAYN.Germany), two of the best-performing stocks in the DAX this year. Aerospace giant Thales (HO.France) is the best performer in the French CAC 40 in 2022. In Spain, it’s the banks that have done well— Banco Sabadell (SAB.Spain) and CaixaBank (CABK.Spain) are among those with the biggest share gains of the past year.
There may, of course, still be bargains to be found among Europe’s consumer-facing firms, especially if the region gets lucky with a relatively warm winter and no further escalation in Ukraine.
Consumers are also being helped by enormous subsidies to help them with energy bills. Since September 2021, European governments have earmarked more than $700 billion to shield households from rising costs, according to the Bruegel think tank.
“If it turns out that the winter is more mild and storage is good, that could be a more positive situation for growth,” says Nomura’s Moran. And if households draw down excess savings from the pandemic to cover energy bills, “we might see consumption being more insulated than we thought.”
Other possible bright spots: Interest rates in Europe probably won’t go as high as those in the U.S. And there’s some hope for an economic pickup in the second half of 2023 after the worst of the energy crisis is behind it.
For now, though, Europe is hunkering down for a difficult winter.